The writer is chief global strategist of Alpine Macro
Rising US bond yields show that financial markets fear Joe Biden’s $1.9tn fiscal package may stimulate the US economy too much and lead to unwanted inflation. But will it? I don’t think so.
Although the US president’s stimulus package seems massive, it consists of several parts, each with a different economic impact. Nearly 40 per cent of the package, or $750bn, will be used to aid mass inoculations and fund states and local governments. This will not produce much of a boost to gross domestic product, although additional funding for local governments could reduce additional lay-offs, which is a positive.
About $1tn will meanwhile be used for direct income subsidies to households in the forms of rebate cheques, child tax credits and higher unemployment benefits. There is also $150bn of financial aid for vulnerable businesses. Overall, household and business subsidies total $1.15tn, although the size of the final package could be trimmed somewhat because of the resistance by Senate Republicans.
Such subsidies are quite different from public sector investment. The former is identical to income tax cuts; the latter feeds directly into GDP growth. They also have very different economic multipliers. Recent experience — for example, that of Australia after the 2008 financial crisis — is that the impact of income subsidies on growth is often negligible. This is because businesses and consumers behave rationally. If a tax cut is one off or transitory, the windfall is usually saved rather than spent.
A case in point is the roughly $3tn stimulus package, passed between March and May 2020. This had a limited effect in boosting growth as consumers not only saved their income subsidies, they saved more of any other income they received. US personal disposable income shot up by $2.4tn between March and May last year. But personal savings soared by more than $5tn.
Similarly, it is far from certain how much of the Biden package’s $1.15tn in consumer and business subsidies will be spent. Granted, with the pandemic seemingly under control and the economy reopening, some of the funds will translate into final consumption. Supply constraints have also led to price rises in some goods. Together, these may cause a one-off rise in inflation.
But assume, say, that consumers save half of the amount they receive from government. That would represent about $500bn in additional consumer spending. This would not be enough to offset the negative output gap, or the difference between current and potential economic activity, which is estimated at about $1tn. It is premature to claim that Biden’s stimulus package will overstimulate the economy and push up general price levels at a continuing rate.
By comparison, Donald Trump’s 2017 tax cuts were worth about $1.5tn, similar in size to Biden’s proposed income subsidies. Although these tax cuts were “permanent” and aimed at boosting corporate investment and consumer spending, they did little to lift long-term GDP or inflation. They did lift corporate earnings and stock buybacks and helped to create a stock market boom. But they did not boost corporate capital expenditure.
As for household disposable incomes, they did rise as personal tax rates came down. Consumer saving rates also rose by 2 percentage points to 9 per cent of disposal income. But consumer spending growth stayed virtually flat. Trump’s tax cuts suggest it is unlikely that Biden’s income subsidies will boost demand by much, or be inflationary, particularly if Biden is forced to reduce the handout by the Senate.
More generally, subsidies to low-income families are certainly necessary at times of economic difficulty. But the government should divert more resources to public sector investment. This adds productive capacity, generates growth, and is better way to boost demand and fight an economic crisis.